Transformations in Tax dividends

Since 6th April 2016, a new dividend tax came into the effect in a bid for determining tax-minimising strategies and incentives for
more people to invest their bonus income instead. The estimated 10% Dividend
Tax Credit has been replaced by a 0% tax rate on the first £5,000 dividends
till 5 April 2018 (£2,000 for a year to 5th April 2019).

Likely, approximately 1 million directors and
shareholders of the UK limited companies will remain unaffected or pay less on
their dividend income. Although, the changes will have a significant impact on
small business owners who pay basic tax rates and take a huge amount of their
annual remuneration as dividends.

Higher and additional taxpayers will also pay higher
dividend tax more than £5,000 allowance than under the previous regime, but it
will be beneficial from the changes if they receive less than £5,000 dividend
per year. The limited company structure is still more tax efficient as compared
to a sole trader. After these changes, the gap between tax savings has become
narrower.

New dividend tax
rates

Before the changes to dividend tax rules, the
basic-rate taxpayers avoided paying the Income Tax and National Insurance
Contributions on their whole bonus income, whilst of the higher tax rates and
the additional rates, which the taxpayers had to pay 32.5% (effective rate of
25% after 10% tax credit) and 37.5% (30.56% after 10% tax credit),
respectively, based on their bonus income and higher than the basic rate
threshold.

Due to the new rules, the residents of the UK are now required to
pay the below-mentioned tax rates on their annual dividend income more than
£5,000 (£2,000 after 5th April 2018):

Basic-rate payers: 7.5%

Higher-rate taxpayers: 32.5%

Additional-rate taxpayers: 38.1%

Example 1:

If you receive a total yearly income of £13,500, which
is made up of £11,500 salary + £5,000 dividends:

You are a basic-rate taxpayer. Neither you have
to pay any dividend tax, nor will you pay any income tax on your salary because
it is within your tax-free personal allowance.

You need to pay 12% Class 1 National Insurance
on your salary between £8,164 (NIC Primary Threshold for 2018-19) and £11,500.

The company will be paying 13.8% Class 1
Employer's NI on your salary £8,164 (Secondary Threshold for the 2018-19 tax
year) and £11,500.

Example 2:

If you receive a total annual income of £45,000.
This consists of £11,500 salary + £33,500 dividends:

You are a basic-rate taxpayer

You will not have to pay any tax on the first
£2,000 of your bonus income, also you do not have to pay any Income Tax on your
salary

The company is required to pay 13.8% Employer's
NI on your salary between £8,164 - £11,500

You will pay a 7.5% dividend tax on remaining
£31,500 of your bonus income.

Example 3:

If you get a whole annual income of £55,000, which is
made up of £11,500 salary + £43,500 dividends:

You are a higher-rate taxpayer

You do not have to pay 12% Class NIC on your
between £8,164 to £11,500

The business will pay 13.8% Employer's NI on the
salary you get between £8164 - £11,500

You need to pay a 7.5% dividend tax on £31,500 of
the dividend amount you earned, and 32.5% dividend tax on the remaining £10,000
of dividend income.

Does personal allowance cover the dividend income?

Yes, personal allowance covers the dividend income. If
you receive a dividend income of £16,500 in the 2017-18 tax year and do not
make incomes from any other sources, then you do not have to pay any tax. The
first £11,500 acts as your Allowance and the remaining £5,000 is covered by the
dividend allowance.

How will these changes affect ISAs and Pensions?

If you receive dividends on shares held in an ISA, this
income will remain tax-free for a long time under the new regime. It implies
that you can save £20,000 of dividend income in an ISA during the 2018-19 tax
year.

The rules for pensions also did not change. The
dividend income that is received in a pension fund will remain tax-free whilst
this amount remains in the pension. When this income is withdrawn, the tax will
be imposed on the dividends in one with the pension withdrawal rules that are
present at that time.